Investing in Society

David Brown sensed something was amiss.
For the past seven years, Brown had given annual gifts
of between $100 and $500 to a cultural institution, a nonprofit
foundation whose mission he believed in.1 He
had begun to hear that the organization was having
financial difficulties. But the organization’s Web site
made no mention of any problem, and communications
painted a rosy picture, touting a record number of
donors and the millions of dollars raised through annual
contributions.

“All the signals were, the ship is sinking,” said Brown,
noting that ticket sales had been dropping for years, a
falloff hastened by the terrorist attacks of Sept. 11, 2001.

Eventually, the president wrote donors a letter
outlining the extent of the problems, confirming
Brown’s fears: In 2002, the foundation ran a deficit of
$35.5 million.

“There’s a lot of good news, and then it’s, ‘Oh by
the way, we have this minor problem which amounts
to $35 million this year,” said Brown. “If I ran operating deficits like that, I’d have been fired.”

Brown was upset. He was upset that the organization had
been running “absolutely colossal operating deficits” for two
years, without informing donors. He was upset about the charity’s
lack of candor. He had concerns about basic decision making:
When the charity finally did come clean, it chose “the
most expensive, inefficient way to get the information into
people’s hands” – sending letters, instead of posting it on the
Web. And he felt increasingly as though, with such large deficits,
his annual contribution hardly mattered.

“You have to ask yourself,” he said, “from an accountability
perspective, are they using their dollars wisely?”

And so he did the only thing he could: He stopped giving.
Though the charity has since posted financial information
on the Web, Brown noted that the organization is not exactly
forthcoming. There’s nothing about the issue on the home
page. Clicking on “Annual Reports” yields the headline “Donors
Provide Generous Support”; to learn about the deficit, one
has to click through again to “Operating Results.”

“I ask a series of questions when I give,” Brown said. “How
are my dollars going to make a difference? How is the recipient
analyzing impact? Do they stay in touch with me? Do they
share the bad news as well as the good? Are they asking the tough
questions? Depending on how they respond over time, I’ll
make my investment decision.”

Most individual donors are not like David Brown. A recent
survey on personal charitable giving by the Atlanta Community
Foundation found that when giving to nonprofits, people
are more motivated by the heart than by the head. The top four
reasons for giving, the foundation reported, were “to help the
community,” “out of a sense of duty,” “because charities are
more efficient than business or government,” and “because
[the] organization helped me or someone I know.”2

“We’ve come to realize that the unfortunate fact is the public
doesn’t in general do research,” explained Bennett Weiner,
chief operating officer of the Better Business Bureau’s Wise Giving
Alliance (www.give.org). “People base their decision on
the appeals they receive, and they respond accordingly.”

But David Brown is part of a growing movement, a new
breed of givers, both individual and institutional. They view
themselves as “investors,” rather than simply donors, who seek
information about the nonprofits they fund, and expect measurable
social returns on their investment, much as investors in
the stock market aim for financial returns. It is with these
investors that the future of the social sector lies.

The Social Capital Market

All those who give to charity, along with the nonprofits they
fund, make up a vast web that we call the “social capital market.”
We use the market analogy because it’s a useful intellectual
and communications construct and metaphor. Comparing
the social capital market to markets for goods and services,
including the financial markets for corporate and individual capital,
we can see that where the latter runs mostly efficiently, the
former is woefully inefficient.3 And we can begin to assess the
kind of changes that need to occur for the social capital market
to run efficiently.4

The social capital market, as defined here,5 is the system that
fills the gaps most nonprofits experience between the revenues
they can earn by providing services or selling products for a fee,
and total outlays. In 1999, for example, nonprofits spent a total
of $712.6 billion, but earned only $523.9 billion in revenue; the
“gap” of roughly $188.7 billion had to be filled by individual,
foundation, governmental, and corporate “investors.”6

The market consists of approximately 1.4 million charities,
including religious congregations,7 in the United States today,
supported by at least 37 million individual donors, more than
400,000 corporate sponsors, and more than 60,000 independent,
corporate, and community foundations.8 All told (including
endowments), charities received $241 billion in 2002.

The bulk of the giving came from individual donors, who
contributed nearly $184 billion to charity. Foundations gave
nearly $27 billion, corporations contributed $12 billion, and the
rest came from bequests.
Religious organizations
hauled in 35 percent of the
donations, with educational
institutions receiving 13 percent;
the rest was spread out
across organizations supporting
a wide array of
causes, from the environment
to human services to
international affairs.9

Players in this market
are adopting the parlance
of their for-profit cousins:
Donors active in the management
of nonprofits are
“venture philanthropists,”
and some charities are
exploring “nonprofit
mutual funds.”10 Nonprofits
such as Greenpeace, Habitat
for Humanity, and the
United Way are now
required to make financial
filings publicly available –
just like Ford, Texaco, and
McDonald’s. Today’s philanthropists,
wrote Business
Week in a recent article
about American giving
trends, “demand … measurable results, efficiency, and transparency
– for bringing a businesslike rigor to philanthropy.”11

The Efficiency Question

But is the social capital market efficient?

This is a crucial question for nonprofit executive directors,
because in an efficient market, informed donors reward nonprofits
that are performing well. Nonprofits will find more
donors more easily, keep those donors engaged over the long
haul, and generate more money for their causes, allowing them
to spend additional time and money on the social problems they
were set up to address.

It’s just as crucial to foundation program officers and individual
philanthropists, large and small, because in an efficient
market, it is easier for philanthropists to find the right nonprofit
to achieve their desired outcomes, rather than settling for
an approximate fit. Furthermore, foundations would be armed
with information about nonprofits, enabling them to give to
those that perform well, rather than wasting donations on nonprofits
that can’t, or likely won’t, use the money wisely. At the
end of the day, in an efficient social capital market, more of society’s
problems can be addressed, at lower cost.

According to the economic literature, an efficient market usually
demonstrates the following four drivers: 1) cost-efficient
processes, in which transaction costs and other process-related
costs are low; 2) robust information flow, such that the information
regarding the intrinsic value and risks of the good or service
is up-to-date and consistently available to all buyers and sellers;
3) value-driven allocation, such that investors seek to reward
higher-value goods and services; and 4) flexibility and responsiveness,
characterized by liquid transactions such that assets can
be bought or sold in the amount and at the time desired,
enabling rapid response to market information.

The stock market is still among the most efficient examples
of a for-profit market because transaction costs are low (with
broker fees barely registering as a total of dollars traded, despite
the tremendous volume of transactions); analysts provide easy
access to information about companies (giving investors quick
access to everything from basic financials to detailed valuations);
companies that do well are rewarded while those that do
poorly are penalized; and transactions are flexible and responsive
(transactions can be made nearly instantaneously; assets are
bought and sold with the click of a mouse).

By these same measures, it’s clear the social capital market
is woefully inefficient.

For starters, it does not have cost-efficient transaction
processes, when compared to for-profit benchmarks. In the
for-profit capital market, companies spend between $2 and $4
raising capital (e.g., legal, marketing, and administrative expenses)
– for every $100 they raise. In the social capital market, however,
nonprofits spend between $10 and $24 for every $100 they earn
through fundraising (e.g., obtaining donor lists, sending direct
mail, or making phone calls). Nonprofit chief executives, meanwhile,
spent between 30 and 60 percent of their time pursuing
donations with such “soft costs” unevenly accounted for in
fundraising costs.12 Foundations and government grantors,
meanwhile, spend about $12 to $19 on administration (including
general overhead and reviewing grant applications) for
every $100 they allocate. Federated givers, those intermediary
organizations such as the United Way and Jewish Community
Federation that collect individual donations and then allocate
dollars to charities, spend approximately $13 for every 100 to
cover their expenses. That means that in the social capital market,
the cost of raising capital consumes roughly 22 to 43 percent
of the funds raised, a dreadfully inefficient process.13

“The resource allocation/fundraising process in America is
a frightfully expensive proposition,” wrote Buzz Schmidt, CEO
and founder of GuideStar, a national database of nonprofits, in
its “Guide for the Responsible Donor.” “This is because gifts typically
are made only after a nonprofit organization goes out of
its way, often at great expense, to raise them. Unlike resource
allocation in the business world, where investors and companies
seek one another out in an information-rich environment, philanthropy
is largely a one-way street.”

Moreover, the social capital market lacks a robust information
flow. Organizations recognized by the U.S. Internal Revenue
Service as tax-exempt public charities have different reporting
requirements. Most religious organizations, and organizations
with gross receipts of less than $25,000 annually, are not required
to file annual returns. Organizations with annual receipts of
more than $100,000 or assets above $250,000 must file the IRS
Form 990, which gives a financial snapshot, including line items
for direct contributions from individuals and foundations, and
fundraising expenses. (Organizations with gross receipts between
$25,000 and $100,000 must file a similar form, the 990-EZ.) All
told, only about one-third of recognized charities must file the
Form 990, and 38 percent actually file.

As recently as 1996, it was very difficult to get a charity’s Form
990. Donors could write to the IRS, or show up at a charity’s front
door and ask to see it. The organization was not required to make
a copy. Today, GuideStar has 990s from 285,000 public charities
and 69,600 private foundations in its database, easily accessible
and downloadable on its Web site.

But as GuideStar officials note, the forms can be suspect; 15
percent of forms have at least one mathematical error, and
expenses can be shifted or hidden. According to a recent
GuideStar study of nearly 84,000 organizations, while 82 percent
of nonprofits reported receiving contributions, only 25 percent
reported any fundraising expenses.

The forms “are virtually useless in comparing one organization
to another, unless the organizations are of similar size,
age, geography, and field of activity,” GuideStar advises on its
Web site. “Further, they tell us nothing about the ultimate or
relative effectiveness of an organization with respect to meeting
its objectives. This is the true bottom line of charity.” (To
combat this, GuideStar encourages nonprofits to provide additional
information about their activities – as we shall see below.)

Unlike many other market models, nonprofits don’t embrace
a uniform standard of accounting and reporting. Moreover, there
is no clear regulatory agency like the U.S. Securities and Exchange
Commission to oversee nonprofits. Some 800 IRS employees
monitor more than 900,000 charities and about 690,000 other
tax-exempt groups.14 But monitoring often falls to the state
governments, which have varying regulations. Some require nonprofits
to file annual financial statements, others do not. And
10 states do not require that nonprofits register with the state
government at all.

“Most states look at charity oversight as an extension of their
role as consumer watchdogs and focus on solicitation,” the
New York Times wrote recently. “Issues of financial mismanagement and governance often fall through the cracks.”15

Indeed, that often means that when it comes to information,
donors must fend for themselves. According to a 2001 survey
by the Wise Giving Alliance, only 49 percent of U.S. donors say
it’s easy to find the information they seek about charities, and
only 50 percent credit charities with making the appropriate
information available. A full 70 percent said it was hard to tell
whether a charity soliciting their contribution was legitimate;
80 percent said a charity’s willingness to disclose information
about operations was “very important.”16

In addition to not having a robust information flow, the social
capital market is inefficient because the allocation process is not
value driven. In the social capital market, by definition, nonprofits
aren’t distributing profits and therefore donors are not
the direct beneficiaries of the return their investments create.
Social returns are difficult to quantify and measure; there are
no standard measures of performance success (the art and science
of outcomes and performance measurement is just beginning
to emerge). Investment decisions are often based on things
like institutional loyalty or belief in a cause, rather than financial
and organizational performance and potential social impact.
The result is that investors give, whether or not the nonprofits
produce social value.

Finally, unlike efficient markets, the social capital market is
neither flexible nor responsive. In the for-profit market, investors
are able to withdraw funds from low-return investments (often
at a loss) and redistribute them to higher-return investments.
In the social capital market, this is not the case. Contribution
decisions – donations to nonprofits, for instance – are largely
final and irreversible.

“When you go into buy a good or service in the [for-profit]
marketplace, you make an assessment as to whether it is performing
as promised, or whether there is some other problem,”
said Weiner. “And you can act on that by not buying it again.

“In the contribution transaction, it’s one direction. You are
making a donation, and the transaction is over when the check
is cashed. As to whether the charity is following through,
donors will only be able to learn if they take time to read about
the charity or go to other sources. It takes some effort for the
contributor to find out more.”

‘A Blizzard of Applications’

As noted, a primary reason that the social capital market is inefficient
is because transaction costs are so high. One way to make
the market more efficient, then, is to reduce the amount nonprofits
must spend on fundraising.

Currently, every foundation has its own grant application
process, forcing nonprofits to spend a great deal of resources
to write a separate grant proposal for each potential funder. “The
way that foundations get money to nonprofits is through this
bewildering blizzard of applications and forms, which serves as
a thicket, a barrier,” said Dmitri Mehlhorn, vice president of the
Gerson Lehrman Group, an investment research firm based in
New York. “Instead of figuring out how to comfort the sick or
educate children, they’re figuring out how to get this money.”

On the flip side, foundation program officers expend time
and resources putting out requests for proposals, the vast majority
of which result in grant requests that are not a good match.
“It’s incredibly time consuming and deeply inefficient,”
Mehlhorn said. “Hundreds of millions of wasted dollars could
be eliminated if you had a more efficient matching system.”

There’s a better way. Three years ago, while working at McKinsey
& Company, Mehlhorn was part of the team of three consultants
who developed a proposal called “Grantweb” – a thirdparty
“matchmaker.”

The idea was essentially this: Grantweb would feature a Webbased
search engine, allowing nonprofits to find potential funders,
and funders to find nonprofits, with the click of a mouse.
Philanthropists would be able to conduct taxonomic searches,
starting out generally, for instance, by typing in “child welfare,”
with the ability to get to more specific causes such as “eliminating
child prostitution in Bangladesh.” Basic financial information
about the nonprofit, including what percentage of
funds go to overhead, would be available through the site,
along with testimonials from customers. The concept is similar
to the “common application” adopted by many undergraduate
colleges and universities, allowing prospective students
to apply to several institutions with only one application.

But Grantweb would be more than a sophisticated matchmaker.
It would also provide one common grant application that
could be submitted to multiple foundations, eliminating wasteful
duplication. Nonprofits would be able to store in-process
applications, and Grantweb would route correspondence
between donor and grantmaker.

“The biggest upshot would be that program officers would
spend less time figuring out who gets the money, and more time
working with financial recipients to make sure impact is
achieved,” Mehlhorn said. “And, rather than the cozy relationships
you have now, where big nonprofits get money from big
foundations, who then re-up the following year, you’d have
more competition among nonprofits, who would bring new
ideas for how to tackle problems.”

The idea for Grantweb gained quite a bit of currency within
McKinsey, making it as far as the world finals of an internal business
plan competition in Venice, Italy. But when Mehlhorn
pitched it to a dozen foundations in 2000, none backed the
idea. He thinks this is partly because it would mean major
changes, and could significantly reduce the need for program
officers, or change they way they work.

But it’s an idea that should be resurrected. Over the long haul,
a more efficient social capital market would mean a more efficient
nonprofit sector, with supply and demand working just
as it does on for-profit firms.

“Some nonprofits that do not exist now would spring into
being, because latent good ideas are sitting in the hearts of
people in the private sector, and they can’t figure out how to get
enough money to start,” Mehlhorn said. “Ineffective nonprofits
would come under attack, and some of them would shrink
… and some of them would cease to exist. Stale old models
would change, or they would die.”

‘Expect a Social Return’

Finding a more efficient way to match donors and nonprofits
is one way to lower transaction costs. The Acumen Fund, a New
York City-based nonprofit, has found another.

The Acumen Fund, more than most nonprofits, is borrowing
vernacular and approach from the business world. “We
were founded in April 2001 with a different model from the outset,”
explained Gavin White, chief marketing officer. “Ours is
a business model based on the goals of the nonprofit sector, but
with the mindset of a for-profit. Ultimately, we’re trying to
demonstrate the power of using market-based approaches to
solving the problems of poverty.”

The fund raises money from individuals, corporations, and
foundations and “invests” it in one of three “portfolios” –
Health Technology, Economic and Civic Enterprise, and Water
Innovations – each with its own “portfolio manager,” aimed at
addressing the root cause of a social problem. For instance, the
fund has invested $2 million in its health portfolio, which supports
a low-cost hearing aid project, a telemedicine network connecting
four private eye hospitals in India, an anti-Malaria bed
net project in East Africa, and development of a portable, lowcost
point-of-care device that is capable of detecting dengue fever
(and could be developed to detect other diseases in the future,
such as HIV, malaria, and measles).

Often, the fund invests in startup enterprises, social innovators,
or new technologies. “Acumen Fund operates very
much like a venture capital fund,” wrote CEO Jacqueline Novogratz
in the organization’s newsletter. “It accepts charitable
contributions from individuals, corporations, and foundations
across the world, then ‘invests’ the funds in both nonprofit and
for-profit enterprises. … It makes grants, loans, and equity
investments. Acumen Fund supports those innovations that
are delivering basic products and services to people who make
less than $4 a day.

“This,” she adds, “accounts for two-thirds of the world’s population,
making it imperative to link these people to the opportunities
of globalization. At the end of the day, Acumen Fund’s
partners do not expect financial gain; they expect a social
return.”

There are several strategic benefits to the portfolio approach.
First, pooling investments of between $5,000 and $5,000,000
from 68 investors, who have contributed $17.8 million over the
past two-and-a-half years, has allowed Acumen to take calculated
risks and do the intensive work of bringing innovations
to scale. “By consolidating the funds of 68 partners,” Novogratz
wrote, “Acumen can significantly increase efficiencies and make
a few bigger bets.”

The portfolio approach also allows Acumen to seek out a
blend of projects – including both startup enterprises and more
established organizations – effectively diversifying risk. “Investors
are not just saying, ‘I want to make an investment in bed nets,’
and putting all of their eggs in one basket,” White said. “They
are spreading their commitment over multiple investments.”

Nonprofit investment vehicles such as Acumen Fund, which
allow givers to share costs and spread risk, help reduce inefficiencies
in the social capital market.

Hang Out the Dirty Laundry

The quickest way to spur more robust information flow in the
social capital market is for the nonprofits themselves to make
more information available about finances and project results.

There are indications that this is already happening. According
to Schmidt, 75,000 nonprofits voluntarily supply additional
information for his organization’s Web profiles, so that investors
can gain valuable impressions beyond the Form 990.

One nonprofit that is doing its part in this regard is NPower,
a Seattle-based organization with 12 regional affiliates across the
country that provides technology assistance to other nonprofits
– helping them understand technology needs, building and
launching databases and Web sites, and maintaining computer
networks.

On its Web site, NPower links to GuideStar, and encourages
browsers to follow the link “For detailed information about
NPower’s financials.” Interested would-be donors can follow the
link and see that NPower reported $510,626 in consulting revenue,
and $117,426 in training revenue in 2001. The organization
lists more than just the requisite financials, taking advantage of
a half-page provided to explain how income is related to mission:
“When we charge for services, our prices are about half those
of comparable offerings in the private sector. The ability to provide
some services for free, and others at very low cost, depends
on a strong base of foundation and corporate underwriting.”

But as CEO Joan Fanning explained, “The 990s are so limiting
in describing who we are and what we do.”

That’s why NPower also takes advantage of GuideStar
Plus, providing additional information about its operations,
including an explanation of a decision in 2002 to split NPower
Seattle into two separate nonprofits, one regional, one a national
umbrella organization. Perhaps more telling, NPower provides
a description of accomplishments:
In 2002, it
“served a total of 1,285
nonprofits, delivered
20,272 hours of handson
technology help,
taught technology skills
to 2,678 nonprofit staff
and volunteers, and
matched 548 volunteers
with nonprofits in need
of short-term technology
help.” It also provides
specific objectives
for growth.
“When I look at
GuideStar, I see it as an
opportunity,” said
Megan McNally,
national development
coordinator. “It’s an
opportunity for us to
give stakeholders a picture of what we do, why we think it’s
important, and how it benefits the nonprofits.”

McNally pointed out another benefit of providing information
– it provides a picture of the true costs of doing business,
which may make donors more prone to give.

“It behooves organizations to be as transparent as they can
be,” she said. “The more information we give about the work
that we do, the more people can see why they should give the
dollar that they give. And we all want donors who … are going
to stay engaged over the long term. If they don’t understand what
we do, then a year from now, they may be disinterested.”

And nonprofits should provide information – whether the
news is good or bad. David Brown, who in addition to being a
donor is the former executive director of FIRST, a New Hampshire-
based nonprofit that seeks to motivate young people to
pursue science, applied the principles he espouses as a donor
to his tenure at FIRST.

“My approach is to put information out there, including the
not-so-positive information,” he said. “If in fact you are having
financial difficulties … you might as well hang the dirty laundry
out there.”

Brown notes, for example, that FIRST posts its annual
report on the Web site – showing a $165,870 operating loss for
2002. While it’s possible such information could make the
organization seem wasteful and turn a would-be investor off,
Brown explained, it more likely “demonstrates a need.”

“If we ran another
operating deficit the following
year, people might
say, ‘What’s wrong with
your business model?’”
Brown explained. “People
look at patterns.”

Investigate Before
You Donate

Just as nonprofits need to
provide more information,
donors – individual
and institutional – need
to go out and seek it, and
make their investment
decisions based on it.

Increasingly, in addition
to GuideStar, there
are social capital market watchdogs cropping up that review nonprofit
performance, making it much easier for investors to
access financial and other information.

The Wise Giving Alliance, whose slogan is “Investigate
before you donate,” is one, compiling extensive reports on
some 500 charities that solicit nationally. The reports are based
on a wealth of information provided by the nonprofit, starting
with a detailed questionnaire, and including the annual report,
audited financial statements, a 990, copies of direct mail appeals,
sample grant proposals, fundraising contracts, bylaws, board roster,
budget plans, scripts of telephone appeals, information on
cause-related marketing, and the articles of incorporation.

The information is evaluated according to a set of 20 standards
in four areas: governance and oversight, measuring effectiveness,
finances, and fundraising. To meet the alliance’s standards,
for instance, organizations must have a board of directors
with at least five voting members, and the board must formally
assess performance every two years. Furthermore, the
nonprofit must spend 65 percent of total expenses on program
activities, and no more than 35 percent of contributions on
fundraising.

Charities that meet the standards are eligible to apply for a
Better Business Bureau national charity seal – a recognition much
like a moving company or insurance firm might covet – which
can be displayed on a nonprofit’s Web site and in solicitation
materials.17 Reports on the charities, meanwhile, are available
through www.give.org, and indicate where organizations fail to
meet the standards.

“I wouldn’t give to an organization if I felt that the pertinent
information was missing, misleading, or hard to come by,”
Schmidt explained. “I have not given to a grassroots poverty services
group because I felt that the objectives were fuzzy and the
strategy inconsistent with what was required. … And I have not
given to a local historical preservation group, despite my admiration
for its mission, because I felt its promotions were misleading
and its strategies inconsistent with both the funding
potential and redundant competitive environment.

“But more often I think about this stuff in the affirmative:
I do give to organizations that do work I value and conduct business
in a way that I think makes their objectives realizable.”

And the transaction doesn’t have to stop once the check is
cut. Investors need to find a way to track the performance of
the nonprofits they fund, accessing information about outcomes,
to ensure they are getting social value from their donation.
Increasingly, foundations have been doing exactly this.

Consider the approach taken by Becky Morgan, president
of the Morgan Family Foundation, a Los Altos, Calif.-based philanthropy
that focuses its giving on youth, education, the environment,
and building communities.

“One of the things that foundations have not done enough
of in the past is to really set the expectations for the grantee,”
Morgan said, “to let them know that in exchange for the money,
we expect them to set some objectives and measure how well
they do.”

To that end, the foundation has a policy that any organization
receiving more than $25,000 annually must provide a
detailed “performance matrix,” listing objectives, baselines,
strategies, and, perhaps most important, outcomes.

“Sometimes a nonprofit will say, ‘The river looks good,’”
Morgan explained. “Well, how many more salmon are there?
How many fewer toxins?”

For example, the foundation funds a nonprofit that aims to
help teenage mothers avoid second pregnancies. The organization’s
matrix lists seven clearly defined objectives, including
that after one year in the program, 80 percent of teens will
increase their knowledge about birth control and the risks of
pregnancy. Scanning over to the outcomes, foundation officials
could see that in fiscal year 2003, based on the results of a
survey, 74 percent of teens had increased their knowledge base
in this area – good, but short of its goals.

If the information in the matrix is vague or incomplete, the
foundation follows up with additional questions. A local high
school recently turned in a matrix with a clear objective: Ensure
70 percent of ninth-graders can read and compute at grade level
by the end of the school year. But under outcomes, the matrix
wrote only that “most students were reading at grade level.”
Foundation officers followed up to find out what “most” meant,
and in this case, they were rewarded: The high school had hit
the target, with 71 percent reading at grade level.

“We’re investing,” Morgan said. “We are investing in improving
the environment, or improving the lives of children. … It’s
an investment in the well-being of people and places. … And
the measurement is all about learning whether or not our
money is being well spent.”

What Impact, Efficiency?

Most individual donors aren’t like David Brown. Most foundations
are not like the Morgan Family Foundation. Many nonprofits
still are not like NPower and FIRST. We don’t have an
efficient way to link donors with nonprofits. We don’t have many
cost-effective mechanisms for investing in innovative new projects
in the social sector.

But what if that started to change? What if donors paused
before plunking down a check, long enough to ascertain whether
the nonprofit had a strong track record in terms of keeping
administrative costs low? What if they took the time to ask hard
questions, and to follow up if the answers were not forthcoming?
What if these investors began to hold nonprofits accountable
for results, demanding evidence that their money has been
well spent?

Buzz Schmidt has thought a lot about this scenario. He has
a clear vision of what the brave world would look like.
“An ideal situation would have informed donors initiating
their philanthropy,” he said. “Charities would be doing their best
to explain their work, so there was no confusion in the minds
of the donor public.

“And if charities did a good job of explaining that work and
performing and meeting objectives, then they would continue
to operate, and they would grow. If there were too many environmental
groups on the Hudson River, they would merge, or
some would go out of business. If there were not enough child
development resources devoted to San Jose, then new nonprofits
would develop, because the actors would be responding
to needs, information, and proactive donor intent.

“You’d have the dynamics that were creating true market outcomes,”
he added. “It would be a market.”

1 In return for speaking about his experience, Brown requested that the institution
remain anonymous.

3 An efficient market, according to economists Paul A. Samuelson and William D.
Nordhaus, is “organized to provide its customers the largest possible bundle of goods
and services given the resources and technology of the economy. That is, allocative
efficiency occurs when no possible organization of production can make anyone better off
without making someone else worse off.” (Italics added.) See Samuelson, P. and Nordhaus,
W. Economics (Boston: McGraw-Hill/Irwin, 1998).

4 This theme has been explored in depth by Jed Emerson as well as by Allen
Grossman, Christine Letts, and William Ryan. See for example Emerson, J. “The
Nature of Returns: A Social Capital Markets Inquiry into Elements of Investment
and the Blended Value Proposition,” Social Enterprise Series No. 17, Roberts
Enterprise Development Fund, 2000; and Letts, C., Ryan, W., and Grossman, A.
“Virtuous Capital: What Foundations Can Learn from Venture Capitalists,” Harvard
Business Review (March/April 1997).

5 James Coleman, Robert Putnam, and others have defined social capital more
broadly. Putnam writes, “‘Social capital’ refers to features of social organization
such as networks, norms, and social trust that facilitate coordination and cooperation
for mutual benefit.” (Putnam, R. “Bowling Alone: America’s Declining Social
Capital,” Journal of Democracy 6 [January 1995]: 65-78.)

10 This concept of venture philanthropy was popularized in “Virtuous Capital:
What Foundations Can Learn From Venture Capitalists.”

11 Business Week, “The Top Givers,” Dec. 1, 2003.

12 “Virtuous Capital: What Foundations Can Learn From Venture Capitalists.”

13 Investments Dealers’ Digest (Dec. 11, 2000) for for-profit numbers; AAFRC, Giving
USA Update (no. 2, 2003) estimates that nonprofit fundraising costs could be
as high as 24 percent across subsectors and organizational size; Council on Foundations
(1999) found that the mean ratio of charitable administrative expenses to
grants was 12.05 percent for independent foundations. In 2001, National Center
for Charitable Statistics Dataweb estimated the ratio of total operating and other
nongrant expenses to total contributions/gifts/grants was 18.8 percent for grantmaking
foundations.

14 Strom, S. “New Equation for Charities: More Money, Less Oversight,” The New
York Times, Nov. 17, 2003.

17 The charity seal program began this summer; 17 organizations currently hold
the seal.

WILLIAM F. MEEHAN III is a director at McKinsey & Company, Inc.,
a global management consulting firm, and a lecturer in strategic management
at the Stanford University Graduate School of Business. Meehan
writes, lectures, and consults on issues of nonprofit and foundation strategy,
governance, and policy. He sits on the board of GuideStar and has
consulted with both Acumen and NPower, all cited in this article. Meehan
is also a member of the Stanford Social Innovation Review advisory
board. He can be reached at bill_meehan@mckinsey.com.DEREK KILMER serves as business retention manager for the Tacoma-
Pierce County Economic Development Board, a nonprofit focused on
expanding family-wage jobs in Washington state. Kilmer is a former consultant
for McKinsey, serves on the board of trustees for Tacoma Community
College, and is vice chair of Communities in Schools of Peninsula,
an education-based nonprofit. He can be reached at derek@edbtpc.org.MAISIE O’FLANAGAN is an associate principal in McKinsey’s San
Francisco office and a leader of the firm’s Nonprofit Practice. O’Flanagan
is a former nonprofit manager and has served as a consultant to a
wide range of companies, foundations, and nonprofit organizations,
including NPower, which is cited in this article. She can be reached at
maisie_oflanagan@mckinsey.com.

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